UK Budget to Boost North Sea Investment

LONDON -- The UK is expected to give the North Sea oil and gas industry a formal guarantee that tax relief for the costs of retiring old rigs and platforms will remain in place for decades, Treasury and industry sources said Friday.

An announcement will likely come as soon as Wednesday, when Chancellor of the Exchequer George Osborne delivers his 2012 budget. The move comes after months of talks between government and industry over possible measures to aid investment in the North Sea.

Under current rules, the government covers around half the costs of dismantling old fields by making them tax deductible, but there are fears among many companies – and the banks that lend to them – that these rules could change.

Certainty that these rules will remain unchanged is expected to encourage a fresh wave of investment in the North Sea, an older and declining basin.

"This should pave the way for billions of pounds of new investment in the North Sea, an industry that supports 350,000 jobs in Scotland and the rest of the U.K. and contributes around 2 percent of gross domestic product," the Treasury source said.

Osborne held a last round of meetings with colleagues before budget preparations entered their final stage Friday, with the chancellor attempting to balance measures to stimulate the faltering economy while still adhering to his aggressive deficit-reduction plan.

Because guaranteeing the rebate will simply codify an existing tax measure, the measure allows the Treasury to encourage investment without any simultaneous reduction in its revenues.

A surprise tax increase on oil-and-gas production last March provoked a storm of protest from companies, with many warning that future investment in one of the world's older oil provinces would be threatened as a result.

Since then, the government has tried to assuage their anger by considering a host of other proposed measures that the industry hopes will encourage continued spending in the region. These have centered on helping companies meet rig-retiring costs, and on tax incentives for firms investing in more expensive marginal or harder-to-reach fields, like the deep-water areas west of the Shetland Islands.

However, there is little chance that last year's increase in North Sea oil taxes will be reversed, a person familiar with the negotiations said. Many senior oil company executives have also said privately they expect the higher tax rate on profits to stay.

As for tax relief on retiring rigs, Osborne is expected to announce an intention to pass into law some form of contractual commitment by government that guarantees current rules on tax relief for decommissioning will still be there at the end of the field's life.

An entire production facility needs to be removed once a reservoir has been exhausted, with its wells plugged and the site returned to as natural a state as possible. The process is expensive and complicated, and poses a number of environmental and safety challenges.

Decom North Sea, a non-profit organization jointly funded by the industry and the government, expects the cost of decommissioning efforts to reach about GBP30 billion ($47.5 billion) by 2040.

The issue is particularly acute for the smaller independent firms that are leading much of the next wave of investment in the North Sea, wringing out the last drops of oil from many of the older fields that were sold off by majors like Exxon Mobil and BP.

These companies have been hamstrung by the legal requirement to provide security, usually letters of credit or large cash deposits, against future decommissioning costs. A tougher economic environment means these companies are finding their access to capital restricted and lenders less willing to issue letters of credit against a backdrop of fiscal uncertainty and declining North Sea production.

An ironclad government assurance on decommissioning could pave the way for at least GBP17 billion ($27 billion) of new investment over the life of the basin, the Treasury source said. Because state help to meet the costs comes in the form of a tax relief and not direct investment, there is no net impact on the Exchequer, the Treasury source added. "It's as close to a win-win as you're likely to get on this," said the person familiar with the negotiations.

Industry lobby group Oil & Gas UK said it would welcome any move to deliver certainty on decommissioning. "Certainty that the current fiscal rules on decommissioning will apply for the long term is crucial to the future of the U.K. continental shelf," said Mike Tholen, the group's economics director.

According to Tholen, the measure could result in an additional 1.7 billion barrels of oil and gas equivalent being recovered and postpone the total shutdown of the U.K.'s oil and gas infrastructure by five to seven years.

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